Question on CCP 508b for Prof. S

[cdmosaic]

Prof. Shays, I know you’ve mentioned this many times, but in reading this breakdown of CCP 580b and 580d I have a question in the 5th paragraph below where it states “(first forecloses, thus selling out the junior lien, who then still has recourse against the debtor).” This seems to indicate that if the 1^st forecloses and wipes out the 2^nd, the 2^nd can come after you for the deficiency even if it was a non-recourse purchase money loan. Am I reading this right or is that only the case if the 2^nd was not a purchase money loan to begin with? The wording is confusing. Thanks!

CCP 580b: This is the purchase money rule. Under this rule, a lender can not pursue a debtor after foreclosure for any deficiency balance as long as the qualifications under 580b are met. That means that if there was a judicial or non-judicial sale, and the lender did not receive their full loan balance from the sale and money is still owed, they can not enforce payment on the difference. Specifically, the statute holds as follows:

To qualify under this statute, you must meet the following three requirements:

1) Purchase Money: The loan must finance the purchase of the property. A refinance will not work
2) Occupancy: The purchaser must occupy the property entirely or in part. Investment property where the purchaser never occupied the property at least in part, will not work
3) Under 4 Dwelling: The property must be residential property with 4 or less families.

How does this play out? If you purchased a home for $500,000 with a $400,000 first deed of trust and $100,000 second deed of trust, which was never refinanced, where there was no fraud or waste, and which you occupied, if the first forecloses and receives $300,000, then the first and second can not pursue you for any deficiency. So even though the first and second are still owed $100,000 each, they are prohibited to pursue the deficiency by law.

Nevertheless, had a refinance been involved or had the second been taken out after the purchase, such as the case in most HELOC loans, then the 580b exception does not apply and both would be able to sue on its $100,000 deficiency, but only in the context of a judicial sale per below, or if the lender was a “sold out junior” (first forecloses, thus selling out the junior lien, who then still has recourse against the debtor). There may also be tax implications as well.

CCP 580d: This is the Trustee Sale Non-Deficiency Rule: Under this rule, once a lender irrevocably elects to proceed with a non-judicial sale, it is prohibited from proceeding any further on any deficiency. That means that if even if there is non-judicial sale, and the lender did not receive their full loan balance from the sale where you still owe money, it still can not enforce payment on the difference.

Unlike 580b above, the loan does not need to be purchase money, there is no occupancy requirement, and there is no dwelling requirement. Thus this rule applies to investment property, commercial properties, and other real estate purchases. Quite simply, if a lender proceeds with a non judicial sale, there is no further recourse against the borrower. This is simply because the lender, at its election, converted the loan from a recourse to non-recourse loan. The election for this remedy is considered final and irrevocable upon the sale.

[The Professor]

The "non-recourse" nature of the 2nd that was a "purchase money" secured loan at the time of its origination (when the home was purchased) is not changed because it becomes "unsecured" as the result of the foreclosure of the 1st loan. It remains "non-recourse." Of course a loan made at a time after the home purchase, or a subsequent refinance of a purchase money loan, effectively eliminates its "non-recourse" nature (although I expect a courageous judge to upset the apple cart on that conclusion given the right facts where a refinance is simply a loan revision where the interest rate is the only real change).

Daniel

[dealingwithHomeEq]

I agree with the Professor:

In Brown v. Jensen, the California Supreme Court extended the purchase money antideficiency protection by holding that purchase money junior lienholders could not bring actions on their notes after the security had become valueless because of a sale by the holder of the purchase money first deed of trust.

30 Los Angeles Lawyer 34, *


Copyright (c) 2008 Los Angeles County Bar Association
Los Angeles Lawyer

February, 2008

30 Los Angeles Lawyer 34

FEATURE: LOCKED OUT: IN FIGHTING A POTENTIAL FORECLOSURE, THE TIME TO ACT IS BEFORE THE SALE TAKES PLACE

by Linda Northrup and Karen Luong

Linda Northrup is the founding partner at Northrup Schlueter, where her practice focuses on real estate and business litigation. Karen Luong is an associate at Northrup Schlueter.

. . .

Deficiency Issues

A client facing foreclosure may not only lose property but also face a deficiency judgment. Counsel must ascertain whether antideficiency statutes will protect the client from having to pay this difference between the amount bid at the foreclosure sale (or the fair value of the property if the bid is lower than fair value) and the amount of the debt. Anti-deficiency statutes are a series of laws, two of which are of primary importance to clients facing foreclosure. One protects 1) those who borrow directly from the seller of a property and give the seller a lien and 2) those who borrow the purchase price on an owner-occupied single family property (a property improved with one to four residential units) and who have offered the property as security for the purchase money loan. 53 This law provides that the seller as lender or the third-party purchase money lender may not pursue the borrower individually for any deficiency under any circumstance (including after a judicial sale). The former residential property owner may have lost the property but can at least walk away from the foreclosure sale without further monetary liability in most cases. 54 The second important antideficiency law protects all borrowers from a deficiency following a nonjudicial foreclosure sale when a deficiency judgment would have been possible if the foreclosure had been done judicially. 55

In Brown v. Jensen, the California Supreme Court extended the purchase money antideficiency protection by holding that purchase money junior lienholders could not bring actions on their notes after the security had become valueless because of a sale by the holder of the purchase money first deed of trust. Normally, a junior lienholder whose security is lost in the foreclosure sale by a senior lienholder (that is, a sold-out junior lienholder) still has the right to sue on the note to recover its debt. However, the Brown court stated:

The broad protection provision (Code Civ. Proc., § 580b) for purchase money trust deeds stands on a reasonable footing. A purchase money trust deed is not like an ordinary trust deed and note....With purchase money trust deeds...the character of the transaction must necessarily be determined at the time the trust deed is executed. Its nature is then fixed for all time and as so fixed no deficiency judgment may be obtained regardless of whether the security later becomes valueless. 56

The above scenario applies only when the junior lien was part of the original purchase transaction. Antideficiency protection applies to liens undertaken as part of the purchase transaction, even when more than one lien exists, as long as those liens were part of the purchase money mortgage. 57 However, if the sold-out junior lienholder's trust deed is not a purchase money mortgage, the lienholder may be able to recover the deficiency against the borrower directly. 58 Therefore, whether the purchase money antideficiency statute applies to bar lienholders from collecting against the borrower depends on the individual facts of each case.

As the housing and credit slump continues, an increasing number of borrowers face foreclosure of their properties. Helping a client navigate through the maze of foreclosure deadlines and rules is a daunting task. Once a foreclosure sale has been completed, it becomes even more difficult to gain any sort of victory for the client. Because attacking a completed foreclosure sale is only available on extremely limited grounds, counsel should work hard at the beginning of the foreclosure process to avoid the undesirable (and many times unavailable) last resort of attacking a completed sale. The borrower's likely financial difficulties--or presumably the borrower would not be in foreclosure--will be a complicating [*39] factor, because challenging foreclosure costs money. There is no easy way out of the foreclosure process, but a thorough knowledge of the available avenues can help counsel navigate the maze, possibly obtaining a favorable result.

[cdmosaic]

Thank you, that helps clarify the situation. My 2nd is part of the original 80/20 loan. My 1st is a refi (no cash out - term change only), but the original 2nd agreed to subordinate to the new 1st, so seems to be purchase money from what I know.

[BDLidd]

Professor, I think we need to clarify that CCP 580(b) does offer anti-deficiency protection to investment property borrowers where the purchase money is financed by seller carry-back. I think you may have stated that 580(b) only applies to owner-occupied residences of 4 or less units. That's only half of 580(b). Do you agree?